'A' for Conduct. 'F' for Guts

"You are lucky, if I may say so, that I'm the one who's standing here and
not the ghost of Sen. Carter Glass. One hesitates to speak for the dead, but
I am reasonably sure that the Virginia Democrat, who regarded himself as father
of the Fed, would skewer you."

-James Grant, addressing the staff of the New York Federal Reserve, March
12, 2012

Once upon a time (but not so long ago), the New York paper-pushers who deem
which textbooks public-school children will read fell upon a history book that
posited some fashionable minority had broken bread during an important historical
event. It was pointed out there was no evidence of such, to which the paper-pushers
agreed: "We know they weren't there, but it's a good idea."

The article is wrong throughout, although, the first sentence may be true: "As
Carter Glass began to sketch out plans for a central bank in 1913, all the
U.S. representative from Virginia had to do was read his mail to know he had
nationwide support." The gist of Torres' reconstruction is the mailbag in Carter
Glass' office, from which the little people (a converter of cotton goods, a
hardware proprietor, a butcher, and a candlestick maker) urged the Senator
to pass a currency reform bill. The Federal Reserve Act became law on December
22, 1913.

Skipping over Torres' study of why we needed the Fed ("America's strong growth
potential was hobbled by a banking system that Glass called 'a rank panic breeder'"),
one is left thinking Senator Glass went to his grave pleased with his accomplishment.
Towards the end of the reporter's interpretation, we read: "For his part, Glass
continued to defend the Fed during its early years. Speaking in the Senate,
where he represented Virginia from 1920 to his death in 1946, he assailed the
old system as 'bank reserve evil' and called the rigid currency and lack of
flexible reserves 'the Siamese Twins of disorder.'"

"Early years" may be taken to mean 1946, still early, from the vantage point
of 2013. By 1917, Senator Glass was distressed with Fed's unaccountable usurpation.

The Federal Reserve Act of 1913 did not permit the bank to buy or hold government
securities. The Federal Reserve Bank was formed to serve the needs of its constituent
commercial banks. Commercial banks dealt in commercial receivables. Economists
were not needed.

H. Parker Willis was Senator Glass' aide-de-camp when the Act was negotiated.
In 1936, he wrote The Theory and Practice of Central Banking. Willis
fumed: "Central banks will do wisely to lay aside their inexpert ventures in
half-baked monetary theory, meretricious statistical measures of trade, and
hasty grindings of the axes of speculative interests with their suggestion
that by doing so they are achieving some sort of 'vague' stabilization, that
will, in the long run be for the better good."

Torres writes the Federal Reserve System would "provide backup currency
and credit - in effect creating a liquid market for the assets held by banks
when they needed money." The system of semi-autonomous regional banks was funneled
into a national bureaucracy. The centralized, open-market operations of the
1920s spawned the illiquid banking system of the early 1930s. Willis (1936)
explained the inevitable consequence of having turned commercial banks into
casinos. In the words of James Grant: "The idea of liquidity, too, had a hard
time of it in the 1920s. A liquid asset, as Willis and his peers defined it,
was a short dated commercial IOU - a money-good industrial purchase order,
for example. Banks had no business owning any asset that did not, upon its
maturity, generate a cash payment. Leave bonds, mortgages, and other long-lived
capital instruments to the savings banks and insurance companies, Willis preached.
Commercial banks were put on this earth to facilitate the exchange of goods,
not to 'create' credit or finance speculation."

Putting oneself in Craig Torres' shoes, what might he write in an unauthorized,
Fed Centennial piece? It might not be much different. Where would he look?
The current "literature" ( per Ben S. Bernanke, ad nauseam) of
economic "science" (BB, ad etc.) has blotted history. In Federal Reserve
Chairman Ben S. Bernanke's Essays on the Great Depression, neither Glass'
nor Willis' names are in the index. This is quite a feat, given that Carter
Glass was co-author of the Glass-Steagall Act of 1933. The World's Greatest
Authority on the Great Depression missed the most important bank reform of
the Great Depression. Banking is central to his blunderbuss theories.

Bernanke is not atypical. The seventh-grade spelling bee champion from South
Carolina undoubtedly received an "A" in conduct from romper room until he received
Stanley Fischer's thumbs-up at M.I.T. It is not an accident that almost all
Bernanke's academic references (the 'literature") are post-1980 academic papers
written in the sandbox of such power-seekers as Professor Stanley Fischer,
who has since gone on to destabilize banks and central banks on two continents.
(Now heading the Israeli central bank, he is buying up the U.S. stock market.)

It might not be literally incorrect, but worth extrapolating the proposition,
that Ben S. Bernanke has never asked a question in his life. He may have asked
if he could go the bathroom or if he could decant extra-credit projects at
Harvard, but he would never put one of his betters on the spot. He pontificates
among a generation of economists who all received an "A" in conduct. (What
is worse, so an insider informs, the next generation of students that has studied
under Bernanke is even more faint-hearted. They are now filling the Fed and
Berkeley faculty ranks.)

This is the way of the world, spinning east, now, to the People's Republic
of China. On the same day Torres' history lesson was released, Bloomberg published: "China
Credit-Bubble Call Pits Fitch's Chu Against S&P." Charlene Chu, at Fitch
Ratings in Beijing, had the nerve to publish some unseemly ratios. Total lending
from Chinese banks and financial institutions rose from 125% of GDP in 2008
to 198% in 2012.

Chu explained: "You just don't see that magnitude of increase" in the ratio
of credit to GDP. "It's usually one of the most reliable predictors for a financial
crisis." To ensure there was no question of her forecast, Chu told an interviewer: "There
is just no way to grow out of a debt problem when credit is already twice as
large as GDP and growing nearly twice as fast"

S&P and Moody's do not, and will not, mention "no way out" assessments
for U.S. Treasury bonds. Until they default, that is. Even then, they hedge
and haw, the unvarying unlanguage within large bureaucracies. (A sample: March
14, 2008 (Bloomberg) - "Bear Stearns Cos.'s credit rating was reduced three
levels to BBB [still investment grade - FJS] by Standard & Poor's after the
securities firm was forced to seek emergency financing from JPMorgan Chase & Co.
and the New York Federal Reserve.... 'Although we view the liquidity support
to Bear as positive, we consider it a short-term solution to a longer term
issue,' S&P analyst Diane Hinton said.") [My bold - FJS]

Other headlines drummed home the presumptuousness of Fitch's analyst: "A China
Credit crisis? Yes, Says a Lonely Fitch analyst" "Fitch Defies S&P
on China's Credit Bubble" [My italics - FJS] Channels that fear losing government "access" bear
the state's message. There is Hilsenrath at the Wall Street Journal.
America's most notable business-news channel suspends appearances by analysts
who are unconscionably bearish. Hitler was asked when he would nationalize
industries. Herr Schicklgruber responded he had no intention of doing so; He
would nationalize the people instead.

Bloomberg TV interviewed S&P's leading light on Chinese credit: concerning
Chinese banks, the pop-eyed fellow earned an "A" in conduct: "This is a good
story unfolding here." When he was asked about Charlene Chu's forecast, the
rising star at S&P spoke with the timidity we've come to expect from government-aligned
corporations: "We will not be the one who will be giving those scare signals."

Shifting continents, a May 25, 2013, Economist editorial certainly
went down well in Brussels and Strasbourg, but did its readers no good. It
should be remembered the European media operates under the fist of ECB President
Mario Draghi, a good reason to find a "good story unfolding here," no matter
how improbable.

The opening paragraph of the Economist's latest Euro assessment: "You
may have missed it, but the European Union held a summit this week. Taking
in a nutritious working lunch, Europe's prime ministers, presidents and chancellors
devoted half of Wednesday to weighty issues of energy and taxation. Gone are
the panic-stricken sessions of last year, dogged by talk of the euro's imminent
failure. Today, Europe's leaders note, reform is under way across most of the
euro zone and some southern European countries are regaining their competitiveness.
The government-debt market is back in its box, where it belongs. And over the
past year share prices are up by a quarter. Nobody could pretend that life
is easy; Europeans understand that hard work and sacrifices lie ahead. But
the worst of the crisis is now safely in the past."

European banks are using toilet-trained, beanie babies for collateral, but
the magazine wins an "A" for good conduct. Hot off the press, a headline: "Spain's
Bankia Decimates Savers As Stock Plummets; Police Officer Stabs Banker Who
Sold Him Shares" The story opens: "While investors across the globe applaud
Bernanke and other central bankers for pushing stock markets to record highs,
retail investors and savers in Spain are facing massive losses. Markets appear
to have forgotten Europe's sovereign debt crisis and the woes in Spain." (Forbes)

There are consequences to running a world with the self-appointed best and
brightest.

Sheehan serves as an advisor to investment firms and endowments. He is the
former Director of Asset Allocation Services at John Hancock Financial Services
where he set investment policy and asset allocation for institutional pension
plans. For more than a decade, Sheehan wrote the monthly "Market Outlook" and
quarterly "Market Review" for John Hancock clients.

Sheehan earned an MBA from Columbia Business School and a BS from the U.S.
Naval Academy. He is a Chartered Financial Analyst.